AL WADI INTERNATIONAL SCHOOL ACCOUNTING GRADE 12

NOTES

PROCESS COSTING
Process costing is a form of operation costing used where production follows a series
of sequential processes. It is used in a variety of industries including: oil refining, food
processing, paper making, chemical and drug manufacture, paint and varnish
manufacture. Although details vary from one concern to another, there are common
features in most process costing systems. These include:
(a)
(b)
(c)
(d)
(e)

Clearly defined process cost centres and the accumulation of all costs (material,
labour and overheads) by the cost centres.
The maintenance of accurate records of units and part units and parts units
produced and the cost incurred by each process.
The averaging of the total costs of each process over the total production of that
process, including partly completed units.
The charging of the cost of the output of one process as the raw materials input
cost of the following process.
Clearly defined procedures for separating costs where the process produces two
or more products (i.e., Joint Products) or where Byproducts arise during
production.

Choice of Cost Units

The cost unit chosen should be relevant to the organisation and its product. In most
cases the appropriate unit arises naturally having regard to the process and the way the
product is sold and priced. Examples include:
Industry
Possible Cost Unit
Brewing
Litre, gallon, barrel
Paint, Varnish
Litre, Gallon
Food processing
Can, Case, Kilogram, Tonne, Litre, etc.
Oil refining
Litres or multiples, Barrel
Basis of Process Costing
The basis of all Process Costing systems is shown in Figure 1:

PROCESS COSTING

Page 1

AL WADI INTERNATIONAL SCHOOL ACCOUNTING GRADE 12

NOTES

It will be seen that materials passes through the various processes gathering costs as it
progresses.
Process Losses
With many forms of production the quantity, weight or volume of the process output will
be less than the quantity, weight or volume of the materials input. This may be due to
various reasons:
(a)
(b)
(c)

Evaporation, residuals, ash.

Unavoidable handling, breakage and spoilage losses.
Withdrawal for testing and inspection.

Because of increasing material costs, careful records must be maintained of losses

occurring and the resulting cost implications. If losses are in accordance with normal
practice, i.e., standard levels, they are termed normal process losses. If they are
above expectation, they are known as abnormal process losses.
Normal Process Losses
These are unavoidable losses arising from the nature of the production process and it is
therefore logical and equitable that the cost of such losses is included as part of the cost
of good production. If any value can be recouped from the sale of imperfect articles or
materials than this would be credited to the process account thus reducing overall cost.
Example 1
A food manufacturing process has a normal wastage of 5% which can be sold as animal
feedstuff at $5 tonne. In a given period the following data were recorded:
Input materials 160 tonnes at $23 per tonne. Labour and Overheads $2896. Losses
were at the normal level. Compute the cost per tonne.
Solution:
INPUT
Materials
Labour and overheads
Less Normal loss 5%
Good production
Cost per tonne of good production =

Tonnes
160
_____
160
8
152
6536/152

$
3690
2896
6576
40
6536
= $43

Note
The $40 credit to the Process account will be debited to a Scrap Sales account, which
will eventually be credited with the actual sale. Any balance on the Scrap Sales account
will be taken to P&L account.
The concept of Equivalent units
At the end of any given period there are likely to be partly completed units. It is clear that
some of the costs of the period are attributable to these units as well as those that are
fully complete. To be able to spread cost equitably over part finished and fully complete

PROCESS COSTING

Page 2

AL WADI INTERNATIONAL SCHOOL ACCOUNTING GRADE 12

NOTES

units the concept of equivalent units is required.The number of equivalent fully

complete units which the partly complete units (i.e., the W-I-P) represent.
For example, assume that in a given period production was 2200 complete units and
600 partly complete. The partly complete units were deemed to be 75% complete.
Total equivalent production = Completed units + Equivalent units in W-I-P
= 2200

3
(600) 2200 450
4

= 2650
The total costs for the period would be spread over the total equivalent production.
Total Costs
i.e.

Cost per unit =

Total equivalent production units

Equivalent Units and Cost Elements

The above illustration of equivalent units is the simplest possible. Frequently some
overall estimate of completion is not possible or desirable and it becomes necessary to
consider the percentage completion of each of the cost elements; material, labour and
overheads. The same principles are used to calculate equivalents units, but each cost
element must be treated separately and then the cost per unit of each element is added
to give the cost of a complete unit. This is shown below:
Example 2:
In a given period production and cost data were as follows:
Total Costs

$
5115
3952
3000
12067

Materials
Labour
Overheads

Production was 1400 fully complete units and 200 partly complete. The degree
completion of the 200 units W-I-P was as follows
Material
75% complete
Labour
60% complete
Overheads
50% complete
Calculate the Total Equivalent Production, the Cost per Complete Unit and the value
the W-I-P.
Solution:
Cost
Element

Equivalent
Units in W-I-P

Fully Complete
units

Material

200 x 75% = 150

1400

PROCESS COSTING

Total
Effective
Production
1550

Total
costs
$
5115

Cost per
Unit
$
3.3

Page 3

AL WADI INTERNATIONAL SCHOOL ACCOUNTING GRADE 12

Labour
Overheads

200 x 60% = 120

200 x 50% = 100

+
+

1400
1400

=
=

1520
1500

NOTES
3952
3000

2.6
2.00

12067

7.90

From the table it will be seen that the cost of a complete unit = $7.90
Value of Completed Production = 1400 x $7.90 = $11,060
Value of W-I-P = Total Costs Value of competed production
= $12067 11060 = $1007
This can be verified by multiplying each element cost per unit by the number of
equivalent units in the W-I-P of each element, thus:
Cost Element
Material
Labour
Overheads

No. of Equivalent
Units in W-I-P
150
120
100

Cost per Unit

$
3.30
2.60
2.00

Value of WIP
$
495
312
200
1007

Note on Example 2
The way that the value of W-I-P can be cross checked by using the cost elements or the
total values should be carefully studied.
Remember:
Total cost for period = Value of completed units + Value of W-I-P
Input Material and Material introduced
The output of one process forms the input material to the next process. The full cost of
the completed units transferred forms the input material cost of the process and by its
nature input material must be 100% complete.
Material introduced is extra material needed in the process and should always be shown
separately from input material. Whenever there are partly completed units at the end of
the period, they may contain two classifications of material, i.e,
Input Material (i.e., previous process costs) always 100% complete.
Material Introduced, which may or may not be complete.
Note
Input material may also be described as: Units transferred, Cost of goods or units
transferred or previous process costs.
Joint products and By-Products
A joint product is the term used when two or more products arise simultaneously in the
course of processing, each of which has a significant sales value in relation to each
other. Examples of industries where joint products arise as follows:
Oil refining
- The joint products include; diesel fuel, petrol, lubricants.
Meat processing
- The joint products include; the various grades of meat and hide.
Mining

PROCESS COSTING

Page 4

AL WADI INTERNATIONAL SCHOOL ACCOUNTING GRADE 12

NOTES

The joint products frequently include the recovery of several metals from the
same crushing.
Cattle farming
- The Joint Products include; milk, Butter, cheese etc.
-

By-Product is a product, which arises incidentally in the production of the main

product(s) and which has a relatively small sales value in compared with the main
product(s). Examples of by-products are:
Iron and steel manufacture
- Furnace slag is sold for use in cement and brick manufacture and for road
construction.
Meat trade
- Bones, grease and certain offal are regarded as by-products.
Timber trade
- Sawdust, small off cuts, bark are usually regarded as by-products.
After the point of separation both joint products and by-products may need further
processing before they are saleable.
By-Product Costing
Because by-Products, have a relatively small sales value, elaborate and expensive
costing systems should be avoided. The most common methods of dealing with byproducts are as follows:
(a)
(b)
(c)

By-product net realisable value is deducted from the total cost of production.
Total costs (main product and by-product, if any) are deducted from Total Sales
value of main and by-products.
By-product receipts are treated as incidental other income and transferred to
general P+L account. This method is generally considered unsatisfactory except
where the value is very small.

None of the by-product costing methods is wholly satisfactory, but method (a) above
probably has least disadvantages. This method is illustrated in the following example:
Example 3
During a period 2400 units of Large were produced and sold at $10 per unit Total
production costs were $17500. Arising from the main production process 60 kgs of Little
were produced which were sold at $8 per kg.
Special packing and distribution costs of $2.20 per kg were incurred for Little. What
were the net production costs and gross profit for the period?
Solution:
$
Less
=

Production Costs
Net Realisable Value of Little
Net production Cost
Gross Profit
Sales Value of Large

PROCESS COSTING

480
-132

$
17500
348
17152
6848
24000

Page 5

AL WADI INTERNATIONAL SCHOOL ACCOUNTING GRADE 12

NOTES

Waste: Waste describes material, which has no value and therefore has no effect upon
the process account; nor will it be included in stock.
Joint-Product Costing
Because joint products arise due to the inherent nature of the production process, it
follows that none of the products can be produced separately. The various products
become identifiable at a point known as the split-off point. Up to that stage all costs
are joint costs, subsequent to the split-off point any costs incurred can be identified with
specific products and they are known as subsequent or additional processing
costs. This is shown diagrammatically in Figure 2.
It follows that subsequent costs after the split-off point do not pose any particular costing
problem because they are readily identifiable with a specific product and an be coded
and charged accordingly. For product costing purposes the major problem in jointproduct costing is to apportion the joint costs, ie, those prior to the split-off point, on an
acceptable basis.

PROCESS COSTING

Page 6

AL WADI INTERNATIONAL SCHOOL ACCOUNTING GRADE 12

NOTES

PROCESS COSTING LAYOUTS

PROCESS 1 ACCOUNT
Material (Units x Material Qty. x Material Price)
Labour (Units x Labour Hours x Labour Rate)
* Variable Overheads (Units x Labour Hours x
VOH Rate)
* Fixed Overheads (Units x Labour Hours x
FOH Rate)

$
xxx
xxx

$
xxx

Transferred to Process 2

xxx
xxx
xxx

xxx

* Note: If based on Direct Labour Hours.

PROCESS 2 ACCOUNT
Material Transferred from Process 1
Added Material (Units x Material Qty. x Material
Price)
Labour (Units x Labour Hours x Labour Rate)
*Variable Overheads (Units x Labour Hours x
VOH Rate)
*Fixed Overheads (Units x Labour Hours x
FOH Rate)

$
xxx

$
xxx

Transferred to Process 3

xxx
xxx
xxx
xxx
xxx

xxx

PROCESS 3 ACCOUNT
Material Transferred from Process 2
Added Material (Units x Material Qty. x Material
Price)
Labour (Units x Labour Hours x Labour Rate)
*Variable Overheads (Units x Labour Hours x
VOH Rate)
*Fixed Overheads (Units x Labour Hours x
FOH Rate)
Work in Progress b/d

$
xxx

$
xxx

Sale of By - Products

xxx Normal Losses

xx Finished Goods Joint Products X
x
Y
xxx
xxx
xxx

Work in Progress c/d

xxx
xxx

xxx

* Note: Work in Progress (Opening Stock) and Abnormal Losses / Gains are not included
in the CIE Syllabus.

PROCESS COSTING

xxx
xxx
xxx

Page 7

AL WADI INTERNATIONAL SCHOOL ACCOUNTING GRADE 12

NOTES

MASTER BUDGETED COST STATEMENT PROCESS 1

Material (Std. Units x Std. Material Qty. x Std. Material Price)
Labour (Std. Units x Std. Labour Hours x Std. Wage Rate)
*Variable Overheads (Std. Units x Std. Labour Hours x Std. VOH Rate)
*Fixed Overheads (Std. Units x Std. Labour Hours x Std. FOH Rate)
Transferred to Process 2

$
xxx
xxx
xxx
xxx
xxx

MASTER BUDGETED COST STATEMENT PROCESS 2

Material Transferred from Process 1
Added Material (Std. Units x Std. Material Qty. x Std. Material Price)
Labour (Std. Units x Std. Labour Hours x Std. Wage Rate)
*Variable Overheads (Std. Units x Std. Labour Hours x Std. VOH Rate)
*Fixed Overheads (Std. Units x Std. Labour Hours x Std. FOH Rate)
Finished Goods

$
xxx
xxx
xxx
xxx
xxx
xxx

* Note: If based on Direct Labour Hours.

FLEXED BUDGETED COST STATEMENT PROCESS 1 (ACTUAL X STANDARD)
Material (Actual Units x Standard Material Qty. x Standard Material Price)
Labour (Actual Units x Std. Labour Hours x Std. Wage Rate)
*Variable Overheads (Actual Units x Std. Labour Hours x Std. VOH Rate)
*Fixed Overheads (Actual Units x Std. Labour Hours x Std. FOH Rate)
Transferred to Process 2

$
xxx
xxx
xxx
xxx
xxx

FLEXED BUDGETEDCOST STATEMENT PROCESS 2 (ACTUAL X STANDARD)

Material Transferred from Process 2
Added Material (Actual Units x Std. Material Qty. x Std. Material Price)
Labour (Actual Units x Std. Labour Hours x Std. Wage Rate)
*Variable Overheads (Actual Units x Std. Labour Hours x Std. VOH Rate)
*Fixed Overheads (Actual Units x Std. Labour Hours x Std. FOH Rate)
Finished Goods

$
xxx
xxx
xxx
xxx
xxx
xxx

* Note: If based on Direct Labour Hours.

ACTUAL COST STATEMENT PROCESS 1
Material (Actual Units x Actual Material Qty. x Actual Material Price)
Labour (Actual Units x Actual Labour Hours x Actual Wage Rate)
*Variable Overheads (Actual Units x Actual Labour Hours x Actual VOH Rate)
*Fixed Overheads (Actual Units x Actual Labour Hours x Actual FOH Rate)
Transferred to Process 2

$
xxx
xxx
xxx
xxx
xxx

ACTUAL COST STATEMENT PROCESS 2

Material Transferred from Process 1
Added Material (Actual Units x Actual Material Qty. x Actual Material Price)
Labour (Actual Units x Actual Labour Hours x Actual Wage Rate)

PROCESS COSTING

$
xxx
xxx
xxx

Page 8

AL WADI INTERNATIONAL SCHOOL ACCOUNTING GRADE 12

*Variable Overheads (Actual Units x Actual Labour Hours x Actual VOH Rate)
*Fixed Overheads (Actual Units x Actual Labour Hours x Actual FOH Rate)
Finished Goods

PROCESS COSTING

NOTES
xxx
xxx
xxx

Page 9